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Two-way road for global monetary policy

August 5, 2014

Monetary policy movements in the world usually take one common direction

Monetary policy movements in the world usually take one common direction, motivated by common factors that affect global liquidity conditions. In this sense, July was an atypical month, with movements in both directions: a little more than half of the 11 countries with interest rate actions cut rates, whereas 5 countries increased rates.

On the loosening side, Peru and Israel surprised with cuts of 0.25 pp each (when stability was expected), and Sweden cut its rate by 0.50 pp (a 0.25 pp cut was expected). The 0.25 pp cut in Chile, after four months of stability, also surprised many in the market, although most participants expected some movement.

Interest rate cuts in Turkey and Hungary were more predictable, continuing cycles that were already in progress.

Movements on the contractionary side were expected, except for the 0.25 pp rate increase in South Africa, over which the market had been divided, some expecting a hike and some, stability. Malaysia, the Philippines, New Zealand and Colombia increased their interest rates by 0.25 pp, in line with market expectations, the latter two continuing their cycles.

In Brazil, interest rates were kept unchanged, but the monetary policy discussion was intense. The Monetary Policy Committee (Copom) maintained the Selic rate at 11% and kept the expression "at this moment" in its post-meeting statement – this was interpreted by some market participants as a sign that there could be change in the monetary rate in the short term. However, in the minutes, the Copom was explicit that its strategy of convergence of inflation to the target does not include changes in interest rates.

1- Policy rates: Historical table

*Blank places mean absence of monetary policy decision for the month.

** Numbers in red indicate rate cuts, in green rate hikes and in grey another monetary policy change different from interest rates.

2. Charts

3. Monetary policy in LatAm

Brazil: Copom: No Rate Cuts

The Brazilian Central Bank’s Monetary Policy Committee (Copom) maintained the benchmark Selic interest rate at 11.00% p.a. in its July meeting, as expected. The post-meeting statement was the same as in the previous meeting, including the expression “at the moment”, which is an expression that the Copom usually adopts to signal a possible change in the course of monetary policy in the short run.

In the context of weak economic activity (particularly the decline in business and consumer confidence), the expression “at the moment” was interpreted by some market participants as signaling that interest rates could be cut in the coming months.

However, in the minutes of the meeting, published one week later, the Copom recognized that inflation will remain resilient in the next quarters, and stated that with “unchanged monetary conditions”, inflation trends towards the target “in the final quarters of the forecast horizon” (i.e., in 2016). More explicitly, the minutes indicated that the Copom’s strategy “does not contemplate a reduction in the monetary policy instrument”.

Hence, the minutes signaled a stable Selic Rate at 11%. Naturally, the strategy of stable interest rates made clear by the Copom is ultimately dependent on the evolution of the economy, particularly the inflation dynamics.

We keep our scenario that the SELIC rate will be maintained at 11.0% until the end of this year.

Mexico: No Rate Move Confirms that June’s Cut Was One-Off

The central bank kept its policy rate unchanged at 3.0% after a 50-bp cut in June. In the concluding remarks of the press statement announcing the decision, the board highlighted the “expected recovery of the economy” and, on the other hand, the “relative monetary policy stance of Mexico vis-à-vis the U.S.” among the factors that it will monitor carefully ahead, suggesting a neutral bias. In all, the statement is in-line with the guidance provided in the past decision: the rate cut in June was one-off.

The minutes of the meeting show that the decision to leave the interest rate unchanged at 3.0% was unanimous. However, two board members (likely the same ones that voted against the rate cut in June) clarified that their vote to leave the policy rate at 3.0% is due to the fact that the rate is already at that level. Most board members indicated that the market reacted positively to the recent cut in the reference rate, considering the behavior of the yield curve (no steepening) and the exchange rate.

We currently expect the central bank to maintain the policy rate unchanged throughout this year and to start a tightening cycle in the last quarter of 2015.

Chile: Resuming the Easing Cycle

Chile’s central bank cut its policy rate by 25-bps to 3.75%. The cut was in line with market consensus. However, the market´s expectations were split almost evenly, as slightly more than 40% of analysts (including us) expected the policy rate to be held at 4.0%, according to the latest survey of expectations produced by the central bank. Although both growth and inflation surprised on the downside, we thought the central bank would wait for further confirmation that inflation is converging to the target center before resuming the easing cycle. Importantly, the board maintained the easing bias in the press statement announcing the decision, repeating that it “will evaluate the possibility of introducing additional policy rate cuts according to the evolution of the internal and external macroeconomic conditions and its implications on the inflation outlook”.

As Chile’s economy continues to be weak, we expect the central bank to continue with the easing cycle, with the policy rate ending this year at 3.5%. At first glance, the additional rate cut would come in August, unless inflation once again surprises on the upside. In addition, considering that activity continues to disappoint, we see growing risks that the board will reduce the monetary policy rate beyond our current forecast.

Colombia: Tightening Cycle Continues

The Central Bank decided to raise the interest rate by 25-bp to 4.25%, in line with both our expectation and the market consensus. This is the fourth consecutive rate hike. The Board considered raising the policy rate as an appropriate measure considering a closing output gap, anchored inflation expectations, increased credit growth and expansionary real interest rates.

While the press release gave no indication that the hiking cycle is about to stop, Governor Uribe declared that the decision was split. Considering the recent debate over a lower equilibrium for real rates, we think that the dissenting vote(s) was for keeping the policy rate unchanged, rather than hiking by more than 25-bps.

We currently expect Colombia’s economy to grow by 5.0% this year and see the policy rate at 4.75% by yearend. The tightening cycle would continue in 2015 (when we expect the policy rate to reach 5.50%).

Peru: Adding Policy Rate Cuts to Help the Economy

As expected by us, Peru's central bank reduced its policy rate by 25 bps (to 3.75%). According to the press statement announcing the decision, the move was based on (i) well-anchored inflation expectations, (ii) below-potential GDP growth, (iii) mixed signals for the global economic recovery, (iv) moderating supply-side inflationary pressures. The board also warned that this decision does not imply - with the current information set – a sequence of interest rate cuts.

In our view, apart from the weak economic readings the loose monetary policy stance in the U.S. was a key factor behind the decision to lower rates. Over the past few months, the central bank was stimulating the economy by lowering local-currency reserve requirements only. With less pressure for a stronger dollar (at least at that point), the central bank found room to use its more traditional monetary policy instrument. Besides, considering how fast credit in local currency is growing and how weak the economy is getting, the board of the bank likely felt that it needed to explore other transmission channels of monetary policy.

We expect the central bank to bring the policy rate to 3.5% before the yearend. For 2015 our interest rate forecast is also at 3.5%. However, considering that Peru’s economy continues to be weak, the odds that the central bank reduces the policy rate beyond our current forecast are increasing.